Marketing Ninja

You’d have to be an idiot to claim that Wall Street is performing well at the moment; the reality is that we’re in a textbook definition of a bear market. However, for reasons that remain inexplicable, people are knee-jerking to the bad news with shrieks of “WE NEED MORE REGULATION” and “FREE MARKET ECONOMICS HAS FAILED!” I’d caution any person with these concerns to quietly stop drinking from the bowl of panic punch for a second and get their facts straight. I’ve even read some hysterical pieces from respected economists who think that this is the U.S. Government moving towards socializing the country’s entire infrastructure; I guess intellectual objectivity goes out the door as soon as a bloated insurance giant needs to borrow money from the FED.

Look, folks, I’m in the same boat as many of you; all of my savings are tied up in Washington Mutual and my fledging retirement fund is invested mostly in the stock market (I chose an aggressive growth portfolio.) Do you think I’m not concerned? Of course I am – but I’m not shrieking like a moron and demanding more Government control of private business in order to prevent…. more Government control of private business?

Let’s distill some sense out of this hysteria.

The AIG and Bear Stearns Bailouts: Total Steals for the Federal Reserve Bank

Let’s talk about AIG first, since that is on the forefront of minds of Americans this morning. AIG is the world’s largest insurer and in exchange for 79.9% of their equity they received $85 billion in funding from the U.S. Federal Reserve Bank. Here are the point-by-point facts worth noting, taken from this morning’s Wall Street Journal:

• The $85b loan from the Fed to AIG has a two-year duration on it with an 8.5% interest rate – this means that the Fed assumes that there is a reasonable probability that AIG will bounce back within that timeframe.
• The fact remains that AIG is a fundamentally solvent company with $1 trillion in assets and $77.9 billion in surplus capital, but the problem is that a large amount of its cash are tied up in non-liquid assets which cannot be tapped for running the day-to-day operations of the company and that is why AIG is borrowing against those assets from the Fed and elsewhere.
• The loans made to AIG by the Fed and other lenders are secured by the aforementioned $1 trillion dollars in assets.
• AIG’s insurance business is still profitable.
• AIG is not going to be run by a government bureaucracy, which is what everyone seems to think. Since the Fed has taken over the vast majority of ownership in AIG they have since fired the incumbent CEO and replaced him with Edward Liddy, the former head insurer of the Allstate Corporation. This is about as far as the Fed is going to go in terms of getting directly involved with the management of the company – they fired the bozo who put AIG in this position in the first place and replaced him with an outsider who happens to be a successful insurer for another firm. Sounds just like what a private bank would do if they took over a business.

Overall, it looks like this might be a total steal for the Federal Reserve Bank. This time last year AIG direct traded at $70 a share; the Federal Reserve just acquired a 79.9% stake in the company for just around $3 a share. The Federal Reserve just purchased an 80% share of $1 trillion in assets for $85 billion – that my friends, is a steal.

The American tax payer is going to see a net benefit, not a loss, for this bail out. Look at how well the Chrysler bailout of the late 1970s turned out for the Fed: people said the exact same thing then that they’re saying about the AIG bailout, that it was a “return to feudalism.” How did it turn out? Well, read this segment from the New York Times for your answer:

You can draw a clear line from the Chrysler bailout to the recent attempts to steady Wall Street. Back then, Washington insisted on a few pounds of flesh, like a wage freeze for Chrysler workers, in exchange for aid. Mr. Paulson has done something similar by insisting that shareholders of the Wall Street firms benefit little from any bailout.

In 1979, the government structured the Chrysler deal so that taxpayers might earn a profit from it (which they did). This year, the Fed effectively purchased securities from Bear Stearns that it hopes to sell for a gain when the financial markets calm down. While it’s way too early to know if the strategy will succeed as well as it did three decades ago, it’s certainly conceivable.

The NYT goes on to insist that perhaps the Chrysler bailout may not have been that successful because it didn’t stop the U.S. Auto Industry from getting steam rolled by the Japanese beginning in the early 80s. I guess the argument that they’re trying to make would have been that if Chrysler collapsed then there would have been this magical alternative history where Ford and GM would have begun producing hybrids (I’m being sarcastic) beginning back in the early 1980s. Sorry, NYT, but I’ll stick with what actually happened (win-win for the Fed and Chrysler) versus a speculative theory that can’t be tested.

The point I’m trying to make this this: we will see a net profit from the Bear Stearns and AIG bailouts, just like how we did from the Chrysler bail out. The Fed drove a hard bargain and acquired over 1 trillion dollars worth of assets at rate of pennies on the dollar.

“Let them Fail” is a Great Idea, if you Don’t Need a Line of Credit over Next Five Years

HotAir ran an idiotic piece this morning which amounted to “we should just let every mismanaged financial institution fail.” While I’m glad that Lehman wasn’t bailed out (costs outweighed the benefits,) I’m also happy that Bank of America has been snatching up failing institutions for pennies on the dollar and that the Fed bailed out AIG and Bear Stearns. As I demonstrated in the first segment of this piece, the hysteria that has overcome the vast majority of the market has resulted in having a number of major institutions valued well below the reality. AIG has over $1 trillion in assets, liquid and nonliquid, but their market cap is hovering around $6.1 billion – AIG’s liability is large (hence the bailout,) but it’s certainly not greater than $1 trillion (good solvency, poor liquidity.)

When I hear presidential candidates on both sides of the aisle crying “oh no, not another bail out – we should have let them fail” it makes me think that they lack the vision to lead this country, let alone objectively analyze a complex financial market. So what would happen if AIG, Fannie Mae, Freddie Mac, and Bear Stearns all failed? Who knows, but I’ll tell you what hasn’t happened yet: credit hasn’t totally dried up. Sure, it’s contracted as a result of doubts cast over the entire lending industry, but it’s still available for people who need it and have demonstrated good credit practices in the past.

The fact that the government has stepped in and stopped some of these giants from falling helps nip some of this hysteria in the bud – we haven’t seen any more bank runs since the IndyMac disaster (thank you, Senator Schumer, for causing that.) So what would happen if we just let these major financial institutions fail? In some cases the result is just a gut-punch to the stock market, as we saw with Lehman, but when major mortgage houses start going under without any help from the Fed then we can see bank runs nationwide, and that would be a real crisis, like the kind we saw in the great depression.

The lesson here is that the Fed isn’t bailing out these companies for the sake of preserving these mismanaged organizations. They’re doing it to stop the development of a greater widespread panic which can result in healthy financial institutions being seriously harmed, and if that were to happen the entire credit industry would be set back for years upon years. We are a society that lives on credit – imagine a world where confidence in all credit institutions has been reduced to zero and no one wants to lend for anything; no credit cards, no car loans, no student loans, no nothing. Try to tell me that spending a few hundred billion now to prevent that catastrophe isn’t worth it.

This entire crisis on Wall Street is the result of the housing bubble; what the Fed is trying to do now is to slowly deflate the bubble, whereas the idiots who advocate the “let all of them fail” philosophy would rather have the bubble burst in one go over our heads. They get upset because they see the direct cost of the Fed’s bailouts written in the headlines of every major newspaper, so they assume that there must be no cost for the alternatives, right? As I’ve pointed out – that mentality is DEAD WRONG. Every choice presents costs, and the Fed has calculated that the cost of having these institutions fail is too great for our financial system to bear. The pundits who are against every bailout regardless of the situation are not thinking like economists, who weigh costs with risks – they’re thinking like politicians, who have the exact same cognitive outcome regardless of costs or risks.

How is Regulation Going to Solve the Problem? Isn’t the same Government Responsible who Handled Katrina so Well?

Back to the title of the article: regulation – how is it going to solve the problem? We already have regulatory oversight on public companies in order to prevent them from cooking the books, so do we need some sort of regulation for preventing companies from making bad decisions? Because that’s what caused this problem in the first place – a bunch of investors deviated from their long term objectives in pursuit of a bubble that couldn’t possible last and now they’re paying for it. Am I pleased that the mistakes of these investors are responsible for swiftly deflating the value of my fledgling retirement fund? Of course not, but do I think that having the U.S. Government step in and regulate all possible investment decisions is a good idea? Hell no.

First, let me address the fact that Fannie Mae and Freddie Mac were created by the U.S. Congress and encouraged to help lower income Americans purchase homes by offering sub-prime mortgages. Government is as much to blame for the current financial crisis as the lemming-like investors are on Wall Street.

Second, there seems to be this mentality among the majority of people that individuals should come running to the Government at the first sign of trouble; so a bunch of banks end up getting screwed because they did what they were encouraged to do by said Government – this is clearly a complete and total failure of the free market system therefore we must abolish it and have mother Government take care of everything for us. Sounds a bit drastic to me; this government can’t even keep a handful of levees up to code in a hurricane-ridden area, let alone manage the most efficient market on Earth better than it already is.

Third, these companies are not getting handouts – they’re getting high interest loans and are paying a hefty price for them in the form of equity. So when I read articles where authors whine about “how come the citizens aren’t getting handouts?” I want to answer “it’s because the average person couldn’t afford to repay a loan with 8.5% interest in two years without winning the lottery.”

The fact is that people want to point the finger at Wall Street and make it out to be some abnormal failure that merits a total overhaul of the entire system. Get a grip, people – the problem was caused by human error, a liability that, I assure you, can be found outside of free market economies. To say that we can prevent all human errors with the steady hand of Government is a ludicrous proposition, given that the Government is arguably more error prone than any free market organization. Putting the Wall Street into the hands of Government and calling for more regulation isn’t the answer – it’s an intellectually vacant copout.

So what’s the answer to the current financial crisis? The answer is to learn that the assumptions behind major investment decisions need to be challenged in order to avoid pitfalls like the sub-prime mortgage crisis – this entire quagmire resulted from a flawed assumption (that the average retail price of a home would remain above $250k) that was factored into a computer model. That assumption was never challenged and now we’re paying the price. Regulation is not a method to prevent bad decisions, it’s an excuse for politicians who are too timid to accept the blame for helping create the sub-prime mortgage monster.

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